Every business requires working capital. However over the period, the term “Working Capital” has bifurcated into many areas. It has changed as per the convenience of the participants. In the modern time, “Working Capital Facility” bifurcates into Fund based and Non-Fund Based. LC Discounting is one of the best and more convenient Non-Fund based credit facilities. The borrower can avail of this facility from the bank.
In the Indian market, being a developing nation, small to medium to big businesses exist here. Without proper financial arrangements, small and medium businesses struggles. Thus, it can impact the overall profitability of the country’s economy.
When the buyer and seller decide to buy and sell the particular product and want to justify the transaction backed by the LC discounting, the process of LC issuance and discounting of LC starts. The standard processes in the LC.
The buyer has to issue the LC to the seller. So he has to approach his banker and request for the issuance of the LC. While applying for the LC the applicant has to provide all the required details for the LC issuance. That may include, the name of the seller, the swift code, amount, details of the products and shipments, etc.
Once all the details are received, the opening bank will issue the LC to the seller. Here the LC issuing bank or advising bank will add the name of the advising bank or where LC is expected to get discounted.
Once LC is issued, the advising bank will cross-check the authenticity and the given details. If advising banks that justifies all the given inputs are correct then it will send the LC to the seller and if any corrections need to be done, it will again send the details to the issuing bank.
Receipt of the LC by the seller. At this stage, the seller receives the LC from the buyer. This is the confirmation to the seller that now his payment is confirmed. So, he starts the proceeding for the shipment of the goods.
Once the goods are manufactured and shipped to the buyer they will not reach immediately to the buyer. Here the seller will get the bill of lading from the port where he has shipped the goods. The seller will take this bill of lading and will submit it to the advising/ negotiating bank.
At this stage, the negotiating bank will take the bill of lading and confirm all the terms and conditions complied. Once those are confirmed, the advising bank will issue the payment to the seller. This process is also known as LC discounting. At this stage, the advising bank will send the documents to the opening bank (The bank that has issued the LC) and will demand the payment.
Once the opening bank receives all the documents, the bank confirms everything with the buyer. Once the buyer confirms all the documents are OK, the issuing bank will take the payment from the buyer and will make the payment to the advising bank.
Understand the execution of LC Discounting from the case study.
Letter of Credit is a financial instrument. One bank issues LC to another bank where the issuing bank agrees, guarantees payment on behalf of the buyer when meet the certain criteria.
The business has no limit to geography. Any buyer can buy the goods from any part of the world and the seller can sell the goods across the globe. However, there is always a risk of the payment and the delivery of goods. The buyer will always have the risk whether the seller has shipped the goods or not. And the seller will always have the risk like after shipment, he will get the payment from the buyer or not. So, In order to nullify this risk from both buyer and seller financial institutions have come up with the financial instrument, called a letter of credit or LC Discounting.
There are mainly four banks involved in the letter of credit.
3) Issuing bank/opening bank
4) Advising banks.
Letter of credit plays a vital role in the working capital, mainly when you’re dealing with international business. Below are a few of the important features of LC:
1. LC is issued against the collateral or FD. This is because, if by means the buyer defaults to make the payment the issuing bank has to make the payment to the advising bank. The issuing bank wants to safeguard its risk of issuing a letter of credit.
2. There are certain charges charged by the opening bank for issuing a letter of credit. The charges depend on the type of LC, bank and the amount, etc.
3. Time to time there are many guidelines issued by the International Chamber of Commerce, which intend to smoother international trade.
4. The payment of the LC is more dependent on the correctness of the documents and not on the quality of the goods and services.
Letter of credit has the advantage, both from the buyer’s perspective and seller’s perspective. Let’s consider both of them.
Advantages to the Seller
1. Protection for the payment
2. Transaction backed by LC is the confirmation of the order and specification. This reduces the risk of the wrong production
Advantages to the Buyer
1. Certainty to receive the goods.
2. Issuing LC shows the financial creditworthiness of the seller. Helps to smoother future transactions with sellers and bankers.
There are many types the buyer and seller can have the LC backed transaction. Below are a few of the LC types.
Issuance of letter of credit in India OR discounting of LC is a complicated process. This requires the expert’s consultation and execution. So, We at Terkar Capital, understand the importance of your international business and the level of risk exposure you are taking. Considering all the angles of discounting of LC and Business, we make sure to provide the best LC discounting in India.
If you have any questions, please reach out.
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